For long, mainstream economists dismissed any downside to free trade as far less significant than the benefits flowing from it. What Paul Samuelson's paper has done is to suggest that the critics might have a point after all.

FOR ACADEMICS, appreciation from their peers counts for more than public applause, and Jagdish Bhagwati probably values the Nobel laureate, Paul Samuelson's description of the recent developments in trade theory as "the age of Bhagwati" more than the Padma Vibhushan he received in 2000 or the Pravasi Samman he was awarded most recently. Yet Bhagwati now has reason to be discomfited by his former professor at MIT. For, after the high praise has come a theoretical challenge to his dearly held dogma of free trade in the form of Samuelson's paper in the Journal of Economic Perspectives titled, "Where Ricardo and Mill rebut and confirm arguments of mainstream economists supporting globalization."

This paper with its tongue in cheek title has created a big splash in the trade policy debate. For long mainstream economists have taken the overall gains from a central component of globalisation, free trade, as almost axiomatic and their logical analysis was pitted against what was seen as the irrational opposition of "warm hearted protesters." Even when some downside was seen as a theoretical possibility, it was dismissed as far less significant than the benefits flowing from free trade. What Samuelson's paper has done is to suggest that those who were dismissed as Luddites might have a point after all and move the discussion of the downside of free trade from footnotes and qualifications in academic papers to headlines in newspapers (as, for instance, "An elder challenges outsourcing's orthodoxy" in The New York Times of September 9, 2004). It has also brought to the fore renewed concerns over the loss of jobs in the United States from outsourcing of services to India and China.

Samuelson challenges the assertion of mainstream economists  naming Gregory Mankiw, the Chairman of the Council of Economic Advisers to President George W. Bush, and Jagdish Bhagwati, among others  that while some groups within a country may lose from free trade, others would gain and the gains of the winners would be larger and could more than compensate the losers, leaving the country better off. He describes the claims of the inevitability of the winnings being larger than the losses as "only an innuendo" and a "popular polemical untruth" and proceeds to disprove it with a rigorous economic analysis of three different scenarios.

Taking the case of the United States and China, he shows in the first case where there is no trade and the U.S. has a comparative advantage in the production of one good and China in another, both will gain with free trade. Again in the second, when China improves its productivity in the good it exports, both countries would stand to gain from free trade. A third case, however, turns out to be problematic and that is when China, through an innovation, improves its productivity in the good it imports, wiping out the comparative advantage of the United States. Here there would be no rationale to trade, and the invention would have "blown away all of the United States' previous enjoyments from free trade." In his remarks to The New York Times, Samuelson went on to clarify that so far the gains to the United States had outweighed the losses from trade but that was not necessarily guaranteed in the future.

Though Samuelson does not make an explicit connection, the references to outsourcing in his paper suggest that the downside of free trade applies to outsourcing as well. For instance, he notes: "High IQ secondary school graduates in South Dakota who had been receiving from my New York bank wages one and a half times the U.S. minimum wage for handling phone calls about my credit card, have been laid off since 1990; a Bombay outsourcing unit has come to handle my inquiries. Their Bombay wage rate falls far short of South Dakota's, but in India their wage far exceeds what their uncles and aunts used to earn." Also, he observes that low skilled workers and lower middle classes could come under pressure as workers in other countries attain higher education and skill levels challenging America's "de facto monopoly in access to the superlative capitals and know-how."

While Samuelson seeks to shake the complacent assumptions of free traders, he makes it clear that his conclusions do not automatically lend support to protectionism. In a mixed world where some inventions help and some hurt a country, free trade, he notes, "may turn out pragmatically to be still best for each region in comparison with lobbyist-induced tariffs and quotas which involve both perversion of democracy and non-subtle dead-weight losses."

Among the economists whose assertions on the virtues of free trade Samuelson challenges is Gregory Mankiw, whose defence of outsourcing as just another way of doing trade that would be positive for the U.S. economy in the long run created a flutter in the run-up to the American presidential elections. Mankiw who was later to clarify that "my lack of clarity left the wrong impression that I praised the loss of U.S. jobs" does not appear to have joined issue with Samuelson so far.

It has fallen upon Jagdish Bhagwati to mount a defence of free trade and outsourcing. This he did in a paper written along with Arvind Panagariya and T.N. Srinivasan titled "The Muddles over Outsourcing" that has been published in the latest issue of the Journal of Economic Perspectives. Their conclusion is that in outsourcing, as in trade in goods, there would be overall gains and while overall losses to one country are a theoretical possibility, they are unlikely. Their paper does not refer to Samuelson but the conclusion that emerges from it is that his analysis applies not to outsourcing but to a different issue of countries like China getting better at producing goods that the United States now exports. That technical progress in a trading partner can wipe out potential gains to America has been recognised in trade literature for the last 50 years and they do not dispute that. Fears over Europeans being hurt when the American economy was growing briskly in the 1950s and again American concerns over the rapid growth of Japan in the 1960s and 1970s reflected theoretical arguments on the downside of trade but they were all allayed by the predominantly beneficial effects.

The same argument is now being made in the context of outsourcing services to China and India with concerns over 300 million highly skilled workers emerging in the two countries. "The oft repeated notion that India and China will quickly educate 300 million of their citizens to acquire sophisticated and complex skills at stake almost borders on the ludicrous," Bhagwati and his co-authors observe. As for the scale of outsourcing itself, it is a "relatively small phenomenon"  the standard estimate provided by Forrester Research in 2004 was that there would be a loss of 3.4 million jobs in the U.S. by 2015. The annual outflow of 300,000 jobs would be a little over 0.5 per cent of the jobs in the occupations concerned, and just a fraction of the 30 million jobs the American economy itself destroys every year even as it creates an equivalent number of new jobs.

They argue that, much more than trade with low wage countries, technical change reduces the demand for low skilled labour even as it creates new, higher paying jobs. The United States may outsource low value services such as back office operations, call centres and data entry but will gain from offering medical, legal, educational, financial, insurance, and other services that provide higher paying jobs. Allaying fears of permanent losses through outsourcing and trade with low wage countries, Bhagwati told The New York Times that the U.S. economy could keep ahead by moving up the technology ladder as it was a reasonably flexible, dynamic and innovative society. For the United States his policy prescription would call for increased investments in scientific research and education to improve skill levels and some form of assistance to protect workers during the period they are out of jobs.

Samuelson's paper does not quite put a spoke in the wheel of globalisation and free trade but it does provide a theoretical stick that traditional doubters like trade union officials and the affected industries could lean on. For a country like India that is placed in very different circumstances, whose trade volume is low and whose tariff levels are still high, doubts over free trade would not seem very relevant as it moves to take advantage of the gains that globalisation offers. Yet the new debate sparked by someone who has been described by Bhagwati as the "the greatest economist of the last century" could boost the protectionist lobby and influence the attitudes and policy on outsourcing in the United States on which depend most of 504,000 Indian workers who currently provide arm's length services over the telephone lines and the Internet in such areas as software development and call centre operations.